CA - Why I'm Not A Buyer Of Waste Management

2023-11-30 17:01:47 ET

Summary

• Waste Management is the largest waste disposal company in North America with a dominant landfill network.
• WM operates in an industry that is hard to penetrate, enabling for barriers to entry.
• Management's compensation is mostly in equity, which I believe should provide investors with confidence.
• My HOLD rating arises from the company currently being fairly valued.

Investment Thesis

Waste Management ( WM ) is the type of business I want to own at the right price and hold forever. Why, you might ask? Well, WM has a dominant position within the industry that is very hard to penetrate. The company benefits from recurring revenue and dependable cash flow, It has downside protection given that waste will be produced in good economic times or bad. I assign a hold solely because the current valuation isn't attractive to me.

Let us dive in.

Company Profile

Waste Management is the largest waste disposal company in North America, providing 21 million customers with waste collection services, transfer, recycling, and more. To put it bluntly, WM's business is turning trash into cash, as a reader commented in my article on RSG services. As of December 31, 2022, WM had 259 owned or operated landfills, of which 254 were municipal landfills and five were hazardous waste landfills.

This level of scale puts the company in the #1 spot in terms of landfill network. WM’s average remaining landfill life was 39 years. Revenue is derived from five product segments: 55% collection, 19% landfill, 9% transfer, 7% recycling, and 10% others (including Renewable Energy). Management and compensation is one of the main things I look for in companies. I like to know how the people who run day-to-day operations are compensated and whether their views are aligned with those of shareholders.

The CEO James C. Fish, owns ~172 thousand shares worth over $28 million. His 2022 compensation was $14.8 million, of which $8 million was in stock awards and $1.7 million in stock options. Mr. Fish has a tenure of 7.3 years. The CFO (Devina A. Rankin) also had over 50% of her compensation package rewarded in stock, and as of 2022, she owned 65.5k shares and 14k options, together worth over $13 million.

Waste management's safety and stability make it an attractive investment for a dividend portfolio. The company has a dividend yield of 1.65%, which has grown by 50% over the past five years. WM has returned $4.5 billion to shareholders since 2018 in the form of share buybacks, decreasing the shares outstanding by 5%. The company has really upped its buybacks in the last two years, suggesting it believes its stock to be undervalued.

The Industry

The waste disposal industry is underpinned by two barriers to entry. First is capital intensity. Waste Management, Republic Services ( RSG ), and Waste Connections ( WCN ) are big spenders on Capital expenditures. Over the past ten years, WM spent an average of $1.9 billion on CapEx, or roughly 10% of revenue, and WCN and RSG spent approximately 11% of revenue.

Because of tight government regulations and activist movements, Municipal waste landfills have severely diminished over the past two decades, enabling companies such as WM to have pricing power. WM's landfill ownership scale is hard to replicate, even for dominant companies within the industry.

According to Statista , in 1990, there were 6326 municipal waste landfills, and in 2018, that figure dropped to 1269. It is very difficult to open or receive approval for new landfills. I believe as the figure keeps decreasing over time, it will become even more of a scarce resource and increase WM's pricing power.

Valuation

WM is trading at a forward PE of 28.36x the FY23 consensus of $5.98 and 25.22x the FY2024 consensus of $6.73. On a trailing free cash flow basis, the stock yields over ~2% relative to its enterprise value.

I estimate revenue will compound at a rate of 4.83% for the next three years, underpinned by price increases and volume growth. I assumed an operating expense margin of 61.60%, SG&A margin of 9.73%, and D&A margin of 10.70% over the same time period.

These three assumptions are based on historical figures, given that WM is a relatively stable business. The 14.00x multiple is at a 6% discount to the current EV/EBITDA FWD multiple and a ~2% premium to a five-year average FWD multiple.

I assumed shares would diminish by 1%, driven by stock buybacks. Using these assumptions and figures, I arrived at a price target of $174.85 for December 31, 2024, translating into a 2% return from the price of this writing.

Risks To Consider

WM is a pretty stable business with recurring free cash flow. This definitely narrows the risks associated with the business, but there are still some concerns. First is competition; Waste Management doesn't just compete with big players such as Republic Services and Waste Connections; they also have to deal with small regional players that will try and jump at any opportunity they get to gain market share.

As of the latest quarter, WM had $15 billion in total debt and $150 million in cash & cash equivalents, yielding a net debt/EBITDA ratio of 2.68x. Although the amount of debt is substantial, It is a recurring theme with the company, given that the five-year average net debt/EBITDA is 2.58x.

Bottom Line

In conclusion, Waste Management is a leading company in an industry that is very difficult to penetrate. This, coupled with the business's stability and recurring revenue, makes WM a top pick for investors, which is perhaps one of the reasons why the company is trading at a fair valuation.

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